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Economics References Committee
Corporate tax avoidance

SADIQ, Professor Kerrie, Private capacity

TING, Associate Professor Antony Ka Fai, Private capacity

VANN, Professor Richard John, Private capacity


CHAIR: Professors, thank you so much for making yourselves available for our inquiry and for your submissions. I am well aware that each of you has had a very public role and has done lots of different op-eds, articles and pieces of media et cetera in this space. We really wanted to get you in fairly early in the process to talk through the broader issues and provide a bit of an explanation of some of the techniques and how this goes about. I now invite you each to make some brief opening remarks—and I stress 'brief' because there are plenty of specific questions, and a lot of what you may have prepared for your opening remarks will be covered by the questions senators have anyway.

Prof. Sadiq : Thank you for inviting me to address the Senate inquiry into corporate tax avoidance and aggressive tax planning. There are three interrelated terms of reference which I wish to briefly comment on. The first is the adequacy of Australia's current laws. We currently have a robust and sophisticated international tax regime and we have been proactive in amending laws when needed—for example, the transfer pricing regime and the thin capitalisation provisions. However, we cannot rest on our laurels and, even though the extent to which tax avoidance is currently affecting Australia's corporate tax base is unclear, reports indicate that aggressive tax planning is occurring. Corporate submissions to the inquiry all tended to say that company X complies with their tax obligations. The fact that base erosion and profit shifting is occurring, coupled with corporate compliance, means they are taking advantage of the current tax rules—and what many are doing is morally wrong. Unfortunately the current tax regime has no basis for addressing morally wrong behaviour. However, appropriate taxes are not being paid in the location of the economic activity. Tax rules need to focus on the underlying economic focus of transactions. To this end, the current laws are inadequate and out of date.

Secondly, we need greater transparency. Corporate tax transparency serves two functions: it informs governments and revenue authorities and it informs the public; the two can be mutually exclusive but do not need to be. In relation to informing revenue authorities a positive step is the automatic exchange of information in the common reporting standard, so Australia needs to continue its support of this measure. More importantly Australia should actively embrace the proposed standardise tax reporting approach under action 13 of the OECD's Base Erosion and Profit Shifting project, or BEPS project. Specifically, action 13 proposes enhanced reporting through a three tiered standardised approach for multinational entities requiring a master file, a local file and a country-by-country report. If OECD guidance is followed, relevant Australian taxpayers will be required to comply by 30 June 2018. Country-by-country reporting will allow revenue authorities to identify gaps where revenue is not being captured and assist them in identifying where their efforts should be directed. In relation to informing the public, the Commissioner of Taxation is now required to publish certain tax details of corporate taxpayers and this legislation should not be watered down. Informing the public builds trust in the tax system and helps to maintain the integrity of the tax base. There is a lack of confidence in the corporate tax system, and the public is calling for corporate social responsibility in relation to tax, not just compliance with tax obligations. Unfortunately very few corporations view tax as an economic contribution to public finances.

Finally, I will speak about opportunities to collaborate internationally and/or act unilaterally to address the problem. The fundamental problem of BEPS can be addressed in two ways: we can fix or amend the laws that allow for aggressive tax planning to take place or we can put in place more robust anti-avoidance laws such as the UK diverted profits tax—or the Google tax. Personally, I believe we should strive to fix the current system, particularly the transfer pricing regime with its flawed arms-length requirement and separate entity approach. This could require an incremental approach, which I believe we are potentially seeing, or a fundamental change to a new system such as unitary taxation with former reapportionment, which is not on the OECD agenda.

The OECD BEPS project is, however, designed to address deficiencies in the current international tax system. The BEPS project is focused on the proper design of the corporate tax system, and its recommendations will be finalised this year. The work of the OECD BEPS project will hopefully give countries the tools they need to ensure that profits are taxed where the economic activities generating the profits are performed and where value is created. To this end, Australia must collaborate internationally and should not act hastily or unilaterally. However, the OECD and the G20 do not make the laws. As such, it will be a case of sovereign nations adopting the recommendations out of the OECD BEPS project and countries like Australia entering into a multilateral convention, altering tax treaties or enacting domestic legislation. This is where Australia must be proactive in adopting OECD BEPS recommendations and also has the opportunity to show leadership within the region.

Prof. Vann : Thank you for the invitation to appear. I did not put in a submission, although I have put in a number of joint submissions to the OECD. I will say a few brief words about the OECD and G20 Base Erosion and Profit Shifting project. I will say a little bit about the structure of the Australian corporate tax system and its enforcement. In light of that, I will then touch on where I think the biggest risks are. The main message is that international corporate tax is not a simple issue and there are no simple single-country solutions; it requires coordinated action. I think the major tax issue for Australia is likely to be foreign corporates with local sales, not so much Australian corporates, for reasons I will explain.

The OECD project is essentially designed to shore up international corporate tax. It is important to understand that corporate tax is essentially a source based tax; it is taxing income where it is earned. It is not a tax levied by the residence country. We tend to forget in this debate that there is another level of tax on shareholders. Shareholders pay taxes on dividends and they pay capital gains tax on shares, and that is the tax that is collected by the residence country. So corporate tax is essentially a tax at source. That means if an Australian company has active business operations overseas the design of our system is quite deliberately that they do not pay Australian tax on that income. The other country collects the tax on that income. It is the Australian shareholders who pay tax on that income when it is distributed or when they sell their shares.

The BEPS project is trying to focus just at the corporate tax level and it is dealing with both systemic issues and design issues in the law. The systemic issues are pretty obvious: the economy has changed; the digital economy has made a big difference to the world. We are seeing an emergence of harmful tax practices not by tax havens but by the UK, the Netherlands, Luxembourg, Switzerland and many other countries who previously did not engage in these kinds of activities. They are passing laws deliberately to attract that income into their country. They are not attracting the activity, just the income—which is a concern. Finally, there is tax competition. Countries do compete for real investment, and that is something you have got to take into account in looking at this issue.

So the design issues are simply defects in the current rules—and Kerrie has already mentioned some of these. This includes transfer pricing rules, the treatment of interest deductions, the business tax threshold of the permanent establishment rule, and information enforcement and implementation. There are clear defects there. I have been writing about those my whole life and nothing much has changed in that time.

CHAIR: I assume it is not an issue for us to table this as a formal document.

Prof. Vann : Yes.

CHAIR: Thank you.

Prof. Vann : I think there are some risk at the moment for the BEPS project. I think it should succeed but we have to be careful. A risk is that it could fail. This is not the first time around. Last time, it started in 1998 and fell over in 2001 when President Bush was elected—he killed it. And the risk is that the US could kill this project at some point. At the moment, the US is gridlocked; it cannot do anything. It cannot change its laws to implement BEPS, nor can it change its laws to do things in the other direction. The project is trying to change rules that took 80 years to create in a two-year time frame. That is a very short time frame for technocrats but it is a long time frame for politicians—and the politicians are getting restive at the moment. In the UK, there is the diverted profits tax. I am somewhat cynical about that. I think it will collect very little revenue. If you look at how they calculate the income, they do not even know how they are going to calculate the income that they will try and collect from Google. There is an election in the UK in a month; that is why they have done it; it is not a sudden conversion on the road to Damascus.

CHAIR: That is a cynicism not shared by the table!

Prof. Vann : So it is a delicate line. Countries like Australia should be prodding the process forward. On the other hand, you do not want to break out because, if everyone goes in a different direction, we will end up with no international coordination.

I will now turn briefly to the Australian taxation system. The government has put out its tax discussion document The government has put out its tax discussion document. Reading between the lines in that document, they want to cut the corporate tax rate. We are collecting too much corporate tax, according to that document; it is not that we are not collecting enough. So the larger picture that the tax discussion document presents—which is not one that I agree with—is that our corporate tax rate is too high and it is a very inefficient tax that has bad effects for the Australian economy. But the main point I want to make about our current system is the imputation system. Again, reading between the lines in the tax discussion paper the Treasury wants to kill imputation. But it is the main cause of integrity in our system. By international standards we are not significantly affected by tax avoidance. Of the countries around the world, we are one of the countries affected the least—because the imputation system creates an incentive for our companies to pay tax. If they want to pay franked dividends to shareholders, they have to pay Australian corporate tax—and our companies, believe me, want to pay fully franked dividends to their shareholders.

On the numbers from the tax discussion paper, we collect corporate tax of $65 billion—although that is rapidly declining because of the collapse in the price of natural resources. Of that, a huge amount is distributed. Only $24 billion is retained—$41 billion is distributed and that shows up as imputation credits mainly for Australian resident shareholders. If the companies do not pay the tax, the shareholders do not get the credits. At the moment, in my view, and it is reflected in both the discussion paper and the Henry review, whilst there is a natural floor on tax planning in Australia—I am not saying our companies do not tax plan, but they have a floor—if companies want to pay dividends of a certain amount to their shareholders and they want them to be fully franked, they have to pay tax up to that level before they can pay those dividends.

In light of that, it seems to me that the real risks for Australia are mainly the foreign corporates. Imputation does not impact them. The shareholders of those companies get no benefit out of imputation. So there is no natural floor on the tax planning in which they can engage. For our resident corporates with mainly local operations and customers—such as our banks and supermarkets—if you look at the Tax Justice Network report, they are paying taxes up near the corporate rate; their effective tax rate is up near the corporate rate. The effective tax rate will never equal the corporate rate—because of timing differences and a whole lot of differences between tax and accounting.

CHAIR: And because of deductions—government policy such as R&D grants.

Prof. Vann : Yes, R&D and a whole lot of other things. There are a whole lot of reasons—some accidental and some deliberate—why there is a difference between the two. So BEPS, for them, is not really an issue. There are resident corporates with significant foreign operations or foreign customers. BEPS is more of an issue with them; they can do some tax planning but, again, imputation puts a floor under the amount of tax planning they can do. If they move income out of Australia and do not pay tax on it, it has an effect, ultimately, on whether they can frank their dividends. More importantly, there is a risk for Australia, in particular, in the BEPS process.

If China starts taxing BHP, Rio and the rest we will not be taxing them. This process could shift tax revenue from Australia to China, so you do need to tread a little carefully when you think about how the process is going to operate. Just to iterate, for me the main concern when you analyse the structure of our system is, essentially, mainly foreign corporates who have little incentive to pay Australian tax.

Prof. Ting : Thank you very much for the invitation. I was especially happy when the chair asked me to cut short my opening statement. Professors Vann and Sadiq have already covered some of my points so I have already removed half of my statement—so it will only be two to three minutes.

CHAIR: We are friends already!

Prof. Ting : I have been researching corporate-taxation issues for the past 10 years. Before embarking on my academic career I was a tax partner of a major accounting firm, serving mainly multinational enterprises. I will jump to what Australia can do to protect its taxpayers. The ideal solution, as Professor Sadiq has pointed out, is international consensus. As transfer pricing is often at the core of most BEPS structures, the ideal solution is to fix the transfer-pricing rules on an international consensus basis. The OECD BEPS project has been trying to do that since 2013; however, the experience so far is not encouraging. Even modest proposals to reform the current transfer-pricing rules have been subject to fears and objections from business and tax professionals.

The fact that some countries do not seem to be wholeheartedly supporting that BEPS project worsens the situation. Research has revealed that the US has been knowingly facilitating these multinationals to avoid foreign taxes. Furthermore, the objective of this involvement in the BEPS project seems to be to undermine the project. If we accept this reality, what can Australia do? It may be worthwhile to consider second-best solutions. An example of a possible second-best solution is diverted profits tax, commonly known as the 'Google tax', which has been just introduced into the UK. Its design may not be perfect but at least it demonstrates what countries can do to protect their tax bases.

It is important to note that Australia should not adopt a carbon copy of the diverted profits tax. It is dangerous to transplant a foreign tax regime into our own tax system without proper consideration of local concerns and constraints. However, the tax does provide valuable experience on the design of an effective anti-BEPS rule in Australia.

In summary, the tax laws should be improved to provide a more powerful weapon for the ATO to challenge BEPS structures. A general anti-BEPS rule may be a second-best solution. It may not be the ideal solution but it may be a pragmatic and effective response to BEPS. Thank you. I will be pleased to answer your questions.

Senator MILNE: Thank you for your advice to the committee so far. There are a couple of issues I want to take up but I will start with the United States. Given what you have said, that they are basically there to frustrate the process rather than facilitate the process, we are having to look at what we are going to do in Australia, notwithstanding we continue the engagement through the G20 and OECD process. To go to the fundamentals of the issue here, as you said in your paper, the problem is a separate-entity doctrine that dictates each company be treated as a separate taxpayer. Given that, they can set up subsidiaries wherever they like, and then the transactions flow from that.

You said that we need to go back and look at tax law so that it looks at economic substance rather than legal form of a corporate group, and that should determine or dictate the income tax implications. How would you actually do that? What would you propose in the Australian context? We have had advice today, and it is certainly my view that we need to legislate to make sure that any company operating in Australia has to identify its subsidiaries. Then you get all the subsidiaries and you know what you are doing and you can then have the tax office pursue it. How would you make the shift to go to the change that you are suggesting?

Prof. Ting : Thank you for the question. Before I answer your question I want to clarify a point. I think Australia should continue to support the OECD's BEPS project. We will get something out of it. On the other hand, because of all the issues I just raised about the US attitude to BEPS we should also think about what I call 'plan B'. What can we do in Australia? That is why I mentioned the diverted profits tax. In its design it basically says the tax office will have the power to tax a multinational's low-tax income sheltered in some tax havens if that structure lacks economic substance. Of course, the actual design will need much more effort to make it effective. Basically what this should achieve is to say, 'Okay, multinationals can set up any company anywhere and then create intergroup contracts.' At present the international tax rule says the starting point is 'we respect those contracts', even though it is internal. You may say it is not real but the law says we respect that and then try to come up with what we call an arms-length price for that contract. If we say that is not working effectively to deal with BEPS, the alternative is to say: if those contracts are not commercially justifiable then the ATO should have more power to say, in a way, I will ignore those contracts and say in a real commercial world, without this kind of intra-group relationship, what the group should do. A current tax case before the court is about interest rates charged by a US group on its Australian subsidiary. The group as a whole can borrow at two per cent. That is the reality. But the Australian subsidiary is paying interest to its own group companies at nine per cent. The ATO is fighting this case and has spent a lot of time and effort on it. The basic question is: it is an intergroup loan, which basically is not real in the sense that it is not paying to a third party, so why should we respect that as a genuine transaction for tax purposes? The enterprise doctrine basically will say that, in that case, because it is mainly tax driven, we should ignore that contract and say that if the group can borrow at two per cent then at most Australia should allow deduction only at two per cent.

Senator MILNE: Yes, but the issue here is: the Parliamentary Budget Office has given advice to say that if you do a diverted profits tax it is contravening tax treaties, and that is why you will not get away with it, because there will be all kinds of challenges around those treaties. Professor Vann was suggesting that there will be other problems associated with diverted profits tax. How do you respond to that?

Prof. Ting : That is why I said in my opening statement that we should not adopt a carbon copy of the diverted profits tax. It has its problems. The UK is very bold in this case. It is very technical, but in the design it very clearly says in certain circumstances I will override the treaty. I do not think Australia should go down that path, but there are other ways to design a similar Google tax that should achieve a similar objective without overriding the treaty. For example, in the tax law we have a general anti-avoidance rule—what we call part IVA. The law says that treaties cannot prevent the ATO from applying part IVA. Basically that means part IVA overrides treaties. It is allowed under the current law. Under the document disclosed by freedom of information by the previous witness, the internal ATO document said part IVA is not effective in dealing with BEPS structures because of the design of the current part IVA. One way to do it is to improve part IVA, incorporate some of the key elements of the diverted profits tax into part IVA so we can use that to deal with BEPS structures.

Senator MILNE: That is a very good suggestion. Professor Vann, you say that the biggest problem in your view is the tech company multinationals where they do not have a substantive business here, but the issue I want to come to is the resource based companies. You are saying that, because of the dividend imputation et cetera, other companies are perhaps not the big issue, but we have had a lot of evidence to say that the resource based companies in Australia are setting up marketing hubs exactly in intergroup arrangements—marketing hubs in Singapore in particular—whereby they get their maximum deductions in Australia for R&D and other concessions but then shift their profit to Singapore, which is a low-tax jurisdiction, so that Australians are not actually getting the benefits that we should be getting from the extraction of our resources. You seem to imply that the resource based companies were in a different category from, say, some of the big techs, so I am interested in your response to that, because it seems to me that we are being ripped off.

Prof. Vann : I drew a distinction between three categories: foreign corporates who operate here; Australian corporates who more or less only operate here like our supermarkets, our big banks and so on; and then our Australian corporates which do have significant foreign operations or customers. The marketing hubs issue is well known. The amount of profit that is shifted compared to the profit those companies are making I think is very small. I am not saying it is an issue which should not be addressed; the ATO is challenging it. It is well known. It is in the papers regularly that the Commissioner of Taxation said we are going after the marketing hubs. It is a transfer pricing issue. They do actually have people offshore who sell their stuff. Some profit has to be allocated to that activity. The question is how much. The ATO says they are allocating too much. They will say what they are allocating is not too much.

So I am not saying—and did not mean to give that impression, but it is difficult in a short statement not to make short statements—that Australian corporates do not engage in tax planning. What I am saying is it is more at the edges. It is not that they reduce their tax more or less to nothing, which the evidence seems to suggest some of the American companies in the digital economy—they still pay tax to a significant degree on their operations in America, but in the rest of the world they pay virtually nothing, and that is largely driven by transfer pricing. That is why Google's profits end up in Bermuda. Most of their offshore profits end up in Bermuda. They are not taxed in Australia or anywhere else. That is because they are moving intellectual property. That is very different from moving a bit of sales activity. So the amount of profits they can shift is virtually all of their profits. The amount of profits that Australian resource companies can shift, I suspect—I have no inside or actual knowledge of it, but from what you read in the newspapers, I suspect they are arguing over what seem to be big numbers in one sense but in the overall context of the amount of tax those companies pay, I think you will find it is a fairly small numbers. Their big mines are in Australia. It is very difficult to move the mine. And we know the iron ore price second by second, so what they can move they have to justify in saying they have all those people over there, they are doing the selling activity and some profit should be allocated to them. I think that is very different from moving intellectual property to Bermuda and all of the profit along with it. I am not saying there are no risks with resident companies, but I think our real risks are with the foreign companies.

Senator MILNE: If you could change one thing domestically notwithstanding the OECD process, what would you change in tax law or one of those associated laws in Australia that you think would make a significant difference?

Prof. Vann : To what?

Senator MILNE: To the ability of corporations operating here to avoid their tax.

Prof. Vann : I guess I would probably not change very much. I would give the ATO more resources. Hopefully, out of the OECD much more information will flow. But I agree with Professor Sadiq and Professor King that there are real systemic flaws in the transfer pricing rules. I do not think there is something we should fix on our own, because, if we are out of line with everyone else, it just creates everyone chasing the dollars, and that at the end of the day will be bad. I think what I would change is being very strong on adopting what comes out of the OECD process.

Senator MILNE: But, if nothing comes out of it because the US frustrates it, we are all back to the same position.

Prof. Vann : I think the US, as I have said, is at the moment different from last time. It could have already put its hand up and said, 'We're not going to go along with this.' I do not agree with my friend Antony that the US is trying to undermine BEPS. I know the US people involved in it. They are trying to get the result that they would like, which is that America can collect more tax from some of the companies, but they are the Treasury. They are not the Congress. The problem in the US is the Congress. You cannot get any tax legislation through Congress, and so they cannot go either way. But, as long as the US sits there and does not object, the process will go ahead. I did not mention it, but there is a comment in my paper that the BEPS outputs are being designed very carefully to inoculate it against US inaction. There are things in it called defensive rules which, in effect, say that, if the US does nothing, the other country can take the money. That is going to be a powerful incentive for the US down the track. So I do not think there is any particular thing that we should do at the moment. I could give you a list as long as your arm of many technical fixes that I think should be made in our law, including in this area, but I do not think there is any one change you could recommend which would produce a bucket of money overnight.

Senator XENOPHON: Professor Vann, you say that it is preferable to have a multilateral approach. That is axiomatic. In the absence of that multilateral approach, perhaps a unilateral approach such as a diverted profits tax or an iteration of it is better than doing nothing.

Prof. Vann : I do not disagree with that, but what I am saying is it is a careful judgement. You have to push the boat forward but not rock it too much so it sinks.

Senator EDWARDS: That is because of our global community, what market signals that sends to all the companies and the distortion that Australia would suffer by virtue of being out in front on this?

Prof. Vann : Yes. For a country like Australia, staying within the pack is a good strategy, but you have to look at your national interest in staying within the pack. It has been our international strategy for many years essentially to stay within the pack, not cut our rates aggressively. I am not saying the diverted profits tax or something like it is a bad idea; I am just saying that, if everyone introduced one, that would be a problem because they would all be different, they would not be harmonised and then we would have break-out.

Senator EDWARDS: The Treasurer's rhetoric on this has been quite strong in the last couple of years. What advice would you give him? I think you said there is a list of recommendations as long as your arm. Are there any concerns you have about the current rhetoric coming out of the government? Be careful what questions you ask, of course!

Prof. Vann : There was the document, which I am sure did not go out without the Treasurer having read it very closely, that in effect says we need to collect less corporate tax, we probably need to get rid of our imputation system and we probably need to cut our corporate tax rate, and on the other hand he says we have all these evil, tax-avoiding multinationals and we should be collecting more tax from them. Overseas, it will be perceived as a mixed message: 'Are you saying you are friendly to us or that you are going after us?'

Senator XENOPHON: We did not say they were evil; we just said they were thieves—there is a difference.

Senator EDWARDS: But doesn't that imply that there is an awareness by the Treasurer that there is a substantial quantum of revenue which he believes that we should be capturing and we are not?

Prof. Vann : I think there is a quantum of revenue and I agree that we should be capturing it. I do not agree, technically, that a number of these structures actually work, because I doubt whether they are implemented in accordance with the way they were designed. But I do not think there is a bucket of money that you are going to collect. The UK diverted profits tax will collect less than $1 billion over three years.

CHAIR: The PBO estimate on a diverted profits tax in Australia, as I understand it, is based on costings that were done based on the UK proposal last year. So, in fairness to the Treasurer, there is not actually a proposal by him on the table; there is a discussion. But what the UK model would have been if introduced was looked at by the PBO and showed a figure as low as, I think, $90 million over four years.

Prof. Vann : Yes, and that is not a reason not to address the fact that there is—

Senator EDWARDS: If it is not a problem, why are we here?

Prof. Vann : Because we will all start saying, 'If they can get away with it, why should we pay tax?' It undermines the morality of the tax system.

Senator EDWARDS: I get it, and I think we are all very concerned about it, but that is the legislation in the UK, which is not addressing the issue; it is tinkering around the edges—that is the assertion—rather than taking the hard line. It is fair to say that Australia is taking a lead in the G20 on these discussions, is it not?

Prof. Vann : We were the president last year, so it was hard not to take a lead. Having said that, we tend to overstate our role in that process.

Senator EDWARDS: What else would you do, then, to be more omnipresent in this space if you were the Treasurer?

Prof. Vann : I would be pushing for the OECD and the G20 to keep the political consensus and doing everything we can to keep that political consensus. Political consensus, as you know particularly, is an extremely fragile animal, and it is something that has managed to hold together. Everyone in America thought this thing would fall over, not because of the US but because the political consensus would crack. The political consensus has not cracked. I think that is the most valuable commodity in town in this process at the moment. We have to push through and get the process done and then start implementing it. Rather than diverting Treasury resources—the Treasury has lost a lot more people than the ATO proportionately in the tax area—its resources will be better spent not putting in some short-term measures. Once BEPS is finalised, if our measures were contrary, presumably we would change them. We should put the resources into keeping the consensus and then implementing what comes out of the process. That will be a significant legislative program.

Senator KETTER: Earlier on, you talked about delivering a bucket of money out of this process. Looking at the figures, Australia's company tax revenue as a proportion of GDP is already above the OECD average. Do you have a gut feeling as to what the potential is for increasing that? Let's say the international process proceeds and there is some degree of success with all of that work. Would you care to give us some figures on that?

Prof. Vann : If we got an extra $1 billion a year out of it, not over the forward estimates, I think we would probably be doing very well. As to the reason we collect so much corporate tax, the other country that is very high is Norway. Why are they high? Because they have a lot of oil. Why are we high? We have a lot of iron and coal. Our corporate tax revenue is going to be dependent, essentially, on the prices we get for our natural resources. That is going to have a much bigger impact than anything that comes out of the BEPS process or anything else—in the area of corporate revenue. On the tax system as a whole, people want to see companies not dodging taxes. That sends an important message. That is why the process is important as an equity and also an efficiency matter. It means multinationals can avoid taxes more easily than local companies. That does not seem right either. But I do not think this is largely a revenue exercise. It is an exercise of making sure that in one important and very public area of our system the rules are working properly.

Senator KETTER: Which companies do you believe are the worst offenders in this area?

Prof. Vann : In Australia I am not sure that there are any who match the ones who are being named internationally, which tend to be the tech companies. But it is not just the tech companies. People have done work on Zara. I know our Treasury has done work on Zara, for example. Zara ships about 25 per cent of its profits into the Netherlands and Switzerland, where it is not taxed. Starbucks: is Starbucks a tech company? No, it is selling coffee.

Senator XENOPHON: Doesn't Starbucks repatriate its profits to some tax haven because of its logo? There is some nominal value put on its logo.

CHAIR: Netherlands.

Prof. Vann : People are buying the image not good coffee.

Senator XENOPHON: You are assuming it is good coffee, as well.

Prof. Vann : That is how the profit has been shifted out of the UK. It is a bit more difficult with Google and Apple. As you know, they stopped deducting the royalty they were paying because people were occupying their stores buying one cup of coffee and occupying all the seats, so they could not sell any more coffee for the day. There was a real consumer backlash in the UK. It had a real impact. But it is very difficult to have a similar kind of popular campaign for some of the tech companies.

Companies with a lot of intellectual property are the ones who have the biggest opportunity to shift the profits. That is not just the big tech companies, but most of our companies. BHP has intellectual property in the form of the way it mines and the technology it uses. But, compared to its value, that is a relatively small part of its value. For Google, Apple et cetera, their intellectual property is a much larger part of their value. They are the companies where the profit shifting is greatest. There is a lot of anecdotal stuff. You can look at many companies around the world who do engage in this. It is more difficult for our companies because they are big resource companies or because they are essentially local companies. They are big companies but with mainly a local market—and that is much harder to shift profit out of.

Senator KETTER: In terms of our current legal framework for addressing compliance and for tackling avoidance, how effective has that been in protecting our revenue base?

Prof. Vann : I will say a few words and then let my colleagues answer. I had a comment in the paper that the ATO historically has been seen as unstrategic. It has not been good at identifying the real revenue risks, and it has not been very good at addressing them. I think it is getting a lot better. You will hear from them today. Like the drift of some of the questions this morning, I agree that there is a problem of the revolving door. But I think that is a problem mainly in the transfer pricing area. I think the revolving door at the top of the ATO is a good thing because it is changing the direction of the ATO. They are becoming much more strategic about picking the fights, picking the areas and implementing them. They have not been very good at implementation in the past.

Senator KETTER: Unless somebody else has a comment on that issue, I would like to go to something you mentioned a bit earlier, Professor Vann. We had been talking about the staff reductions at the ATO, and you touched on staff reductions in Treasury as possibly being more important to consider. Could you elaborate on that please?

Prof. Vann : Well, I know more about Treasury because I have more to do with the Treasury nowadays, although I had a lot to do with the ATO in the past. Treasury have lost about a third of their workforce, and out of the tax area—where you have got tax reform, you have got BEPS, you have got all these things going on—they have lost a huge proportion of their workforce, and a lot of the people they have lost have been very experienced. So it is very difficult for them to do the work that they have to do at the moment. It has always seemed short-sighted to me, on the revenue-raising side, to apply efficiency dividends in the form of staff cuts to those areas.

The ATO has been more shielded, so that although the ATO has been subject to efficiency dividends in virtually every budget in the last decade, there is also a pot of money that is handed to them for a particular project. So people can say, 'yes, the ATO has just gone through a lot of staff cuts', but also they are hiring people in other areas. I do not think you will find that their numbers now are significantly different from the norm of the last decade. They go up and down but they are around 20,000-plus mark, typically. It is how you use the resources in the ATO, I think, that has been the problem. But they know better than I do—I am not very close to it now—what impact the reduction in staff resources is having.

Senator KETTER: Again, I am not sure who my next question is best directed to. Professor Vann, you have made some comments about the UK's attempts to address this issue. You have been less than complimentary, I suppose, about that. Are there any other OECD countries that have taken any steps in this area which we could look at?

Prof. Vann : Yes. Within Europe, the European Union has changed one of their directives to address one particular form of base erosion which is a payment from a subsidiary to a parent company, which in the subsidiary's country is seen as interest and deductible, and in the parent's country is seen as a dividend and exempt. The EU has changed its law to say that if it is deductible at source, it is not exempt in the resident country. We changed our law last year—section 23AJ as it was; section 768-5 as it now is—in the exact opposite direction. We have encouraged a system where you can deduct in one country and exempt in Australia; I will not go into the technicalities of it. But the draft legislation for that came out on the eve of the Tokyo BEPS summit which Australia mounted last year, and it just surprised everyone who was there. So that is an example: we could change our participation exemption to say that if it is deductible in the other country, it is not exempt here. Europe has done that as a whole. In addition, a number of countries, like France, in Europe had already done it independently, knowing that the EU was going to do it anyway. So there are things, but they are not the big picture; they are things which have already been agreed within the BEPS project and are not going to change. Some countries are implementing those. That is very different from that diverted profits tax, which is not an area where agreement has been reached yet.

Senator KETTER: On the initiative that you have just talked about which has been implemented in the EU, are you able to put some figures as to how that might improve our revenue base?

Prof. Vann : I suspect Treasury would score it as a star, which means the revenue is not material. These things are an accumulation. The hope in the UK is that the diverted profits tax will collect exactly nil because Google will set up an office in the UK and pay ordinary corporate tax. The diverted profits tax is set at 25 per cent. The UK corporate rate is 20 per cent. The idea is that companies will give up their tax planning and just bring themselves into the system and pay the ordinary corporate tax. So you will never know, and it is very difficult to score, what the number is. But, as was said, the number is not large.

Senator KETTER: Often it is not the main game. It is the change in behaviour which is—

Prof. Vann : A change in behaviour and a change in perception.

Senator CANAVAN: I want to take a step back and ask a more fundamental question. My dad hates paying tax; he proudly engages in the national sport of trying to minimise his tax. He thinks any extra tax he pays is more for us to waste. I remember as a kid he used to tell me nightmare stories about the ATO—how they could come into your house late at night, take all your stuff, they have all this power with the anti-avoidance rule and other things. If you ask most small businesses and families whether the ATO has too few powers, I do not think their reply would be 'yes'. Yet we are here arguing about it, saying that they do not seem to have the powers to deal with these large businesses. Why is it that they have enough power to deal with small businesses in Australia but not large businesses? What is the fundamental problem?

Prof. Vann : Resources. Small business has zero resources; the ATO has a lot compared to them. When you come to the multinationals, it is the other way around. Relatively, the multinationals have a lot more resources that they are throwing at this than the ATO can throw at it. And the multinationals are used to dealing with tax administrations around the world. For most small business people—I am partly in that category; I do not ever want to be audited by the ATO; I do not have any tax planning; I just pay the tax—it is an uneven fight. Whereas for the multinationals, it is uneven, but it is uneven the other way. That is very difficult—

Senator CANAVAN: Is the problem, then, not the laws, but the appeals process or the court processes that allow large companies to employ tax experts and make court cases extremely costly? Does that make the ATO risk averse from taking on actions?

Prof. Vann : There is an element of that, but I think the structure of the rules at the moment—transfer-pricing rules in particular—makes them hugely information intensive. The companies have the information, but the ATO does not and the ATO has to extract the information, which is very difficult. Companies do not come and say: 'We know you want all the information which will show that we should pay more tax. Here it is.' They disclose what they are asked to disclose, but they disclose the least possible information that may damage them. They are the only ones who know the information. You cannot tax what you cannot see, and that is the problem with our transfer-pricing rules at the moment. It assumes the ATO can learn the truth about what the companies are actually doing—where their value-adding actually occurs. That is very difficult.

Senator CANAVAN: How do the court systems work right now? Is it a tribunal or an arbitration process? Are there appeals? If they are going to have a fight about an arcane dispute on transfer pricing, how long can companies drag such a case out? How much would it typically cost?

Prof. Vann : We have only had two of those cases in Australia since 1963—transfer-pricing cases on the substance, as opposed to the strategy or the procedure. The ATO lost one of those; it half won the other. One of them involved $1 million in tax; it would have cost each side about $5 million to fight the case. I have never understood why that case was fought. The other case involved a lot more tax; the ATO would have spent millions, but they got about another $50 million in tax. It would have been 10 years before that case was heard.

Senator CANAVAN: Are cost orders applicable in such cases?

Prof. Vann : If the ATO loses, it has to pay the costs. In both cases, the ATO did not completely lose—it mainly lost one and partly lost the other. I suspect that in the one they partly lost, each party paid their own costs, but I would have to go back and check. In the other the ATO would have paid most of the costs.

Senator CANAVAN: Professor Ting, you mentioned the general antiavoidance rule. I want to drill down on that. I understand we are one of the few countries that have something like this. Why can't that be used more broadly to tackle these issues? If a structure is put in place for the primary purpose of avoiding tax, why can't we use that rule?

Prof. Ting : You can ask the same question to the ATO.

Senator CANAVAN: I certainly will.

Prof. Ting : They will have a much better answer. Basically I understand that part IVA will apply if the ATO can prove that the dominant purpose of the structure is tax avoidance. As Professor Vann just mentioned, the problem is information asymmetry: multinationals have all the information and the ATO has just information provided by the multinationals. In a real case that is very complex it is very difficult for the ATO to have enough information to substantiate that the dominant purpose of the structure is tax avoidance because multinationals will always put up a lot of commercial reasons and they have industry experts and so on to prove that commercially they have to do it that way. So it is very difficult for the ATO to argue successfully on part IVA on these kinds of structures.

Senator CANAVAN: Basically they need as much information to do that as they would for the transfer pricing case, is that what you are saying?

Prof. Ting : Yes.

Senator XENOPHON: Given Senator Canavan's dad's fear of the ATO, maybe a cup of tea with Chris Jordan, the Commissioner, might be in order! Professor Sadiq, in relation to the Parliamentary Budget Office's work in respect of the unilateral introduction of a so-called Google tax, a diverted profits tax, there was fear expressed that it could provoke revenge taxes being imposed on Australian businesses operating overseas. How likely do you see that as a scenario? Do you see that as more of a fear campaign not to do anything unilaterally in the absence of a broader multilateral action?

Prof. Sadiq : That is a difficult question to answer because it is hard to know what other countries plan to do, but it is part of the reason why I think it is very important to keep working with the OECD and the G20 on the BEPS project so that we do not necessarily have to get to the stage where we go for the second-best option and look at something like a Google tax. We do not want all of these unilateral approaches that do not marry up. That is the worst-case scenario. We want this collaboration. I agree with Professor Vann that the BEPS project is very different now to what we saw previously. The US may not be quite so negative about it but the other thing is we have a very different group of countries involved now. We have the BRIC countries playing a fairly large role in the OECD BEPS project which we had not previously seen. The OECD has been very inclusive.

Senator XENOPHON: Sorry, can I just interrupt because time is limited?

Prof. Sadiq : Yes.

Senator XENOPHON: I am happy for you to answer this on notice if you want.

Prof. Sadiq : Sorry.

Senator XENOPHON: That is okay. A multilateral approach is preferable but it may be that the Australian government will in the budget come up with a Google tax—and I know our Treasurer has been in discussions with his counterpart, George Osborne, in the UK. How likely do you think it is that it will provoke some multilateral retaliation? Do you think that is a bit overblown in terms of Australia being punished by other countries by simply trying to get some of these high-tech companies paying their fair share of tax?

Prof. Sadiq : In essence, I think it is probably overblown.

Senator XENOPHON: Thank you. Senator Canavan touched on tightening the part IVA provisions. Professor Ting, would you mind providing on notice, sooner rather than later, your thoughts on that because that might be very useful to the committee?

Prof. Ting : Yes.

Senator XENOPHON: Professor Vann, you mentioned—and perhaps I did not get it quite right—that international tax minimisation has now been made easier rather than more difficult as a result of some changes to our tax laws about a year ago. Is that right?

Prof. Vann : Yes. What is called the participation exemption now applies to things that are not shares and that means they are more likely to be deductible in the other country and exempt here. Why we made that change—

Senator XENOPHON: I am not sure how that one slipped through this committee, Chair.

Prof. Vann : I am not quite sure. When it came out I was with a bunch of people from some of Australia's largest companies and they all shook their heads and said, 'What are they doing?'

Senator XENOPHON: All right. Could you, on notice, provide us details as to how you think it could be tightened up in respect of that.

CHAIR: Strangely, we are running on time. We do appreciate you taking the time today, Professor Ting, Professor Sadiq and Professor Vann. Thank you for your participation at our inquiry. I know you have taken a few things on notice. We may call on you again for some of your technical expertise, as we go through this process.

Proceedings suspended from 10 : 30 to 10 : 46